On Friday we showed that according to the latest fund flow data, anecdotal speculation of a marketwide melt-up was indeed the case. As a reminder, earlier in the week, we discussed how market optimism among both professional and retail investors had hit the highest level since just before the crash of 1987…
… with a recent E-Trade survey disclosed that 8 out of 10 retail investors – the highest on record – were certain that stocks would continue to rise in Q1. Then, BofA calculated that the 4-week inflows into equities was not only “thundering”, it was the largest ever. This is the result of a massive $23.9bn weekly inflow into equities which brings the 4-week inflow to stocks to the biggest ever, $58bn as shown in the below…
and there was even some good news for active managers: the 4-week inflows to active equity funds was at a 4-year high, although the relentless market share theft by ETFs is unlikely to change any time soon, and certainly not if the market keeps levitating with virtually no volatility.
Also on Friday the S&P’s Relative Strength Indicator rose to a new all time high, suggesting that as of this moment, the US stock market is the most overbought ever.
Now it’s JPMorgan’s turn to opine on recent market euphoria, which – in the aptly named weekly “Flows and Liquidity” report, arguably JPM’s most interesting publication – it says that as of Friday, “momentum signals have reached extreme levels for the S&P” which to JPM’s Nikolaos Panigirtzoglou suggests that “equities are vulnerable to near-term profit taking.“
Why? JPM observes that after revisiting the bank’s momentum-based indicators, shown in Tables A5 and A7 below which it uses to infer how CTAs and other momentum-based investors are positioned across various commodities as well as equity indices, US sectors, bond futures and currency pairs….
… JPM noted that “momentum was approaching extreme levels in the S&P 500, along with the Nikkei as well as crude oil futures.”
The tables reveal, that in the just passed week, the continued strong momentum in risky asset prices saw the z-score of JPM’s S&P signal triggering the mean reversion overlay on Thursday after pointing to longs for around a year and a half.
This means that at long last, the market “could be at levels where momentum-based investors would begin to take profit on their positions.”
Additionally, the continued sell-off in bond markets has seen z-scores for US Treasury futures shift further into negative territory, “but they remain some way away from extreme levels.” Finally, for oil, momentum retraced some of the recent strong gains after Brent oil prices declined from a peak of just over $70 per barrel, though as Chart A39 in the Appendix shows speculative.
To recap: CTAs and other momentum-factor based investors are now at and beyond levels where they traditionally take profits. This could start happening as soon as next week, especially should the market be spooked by the uncertainty surrounding the government shutdown, which as Goldman said yesterday “could last a few weeks”, and near the date of the US debt ceiling D-date, some time in early March, by which point stocks will really sell off if there still is no funding deal.